China must invest in manufacturing

By Zhang Monan 張茉楠

On average, China’s industrial enterprises are relatively small and, although its industrial labor productivity (real manufacturing value added per employee) has improved over the past decade, it remains much lower than that of developed countries — just 4.4 percent of the US’ and Japan’s productivity and 5.6 percent of Germany’s. The “pauperization” phenomenon — in which companies must adjust their commercial strategies to cope with an impoverished consumer base — is increasingly affecting traditional industries, further undermining China’s capacity for sustainable development.

The quality of Chinese-manufactured products also continues to lag behind that of developed countries’ goods.

As China’s “demographic dividend” disappears, its low-end labor market is shrinking, driving up its once rock-bottom labor costs and diminishing its rate of return on capital.

Over the next decade, as Chinese workers demand higher salaries, basic benefits and improved working conditions, the country may well lose the comparative advantage that has driven its manufacturing boom.

While manufacturing wages remain significantly lower in China than in the US, the rapidly narrowing gap is already fueling US reshoring: Chinese wages are rising at an annual rate of between 15 and 20 percent, productivity-adjusted wage rates in low-cost US states are expected to exceed those in some coastal regions of China by only 40 percent in 2015.

Add to that reduced energy costs in the US, owing to the country’s shale-gas revolution, as well as the global supply chain’s complexity, and China’s cost advantages will soon be negligible.

Other emerging economies — including Vietnam, India, Mexico and Eastern European countries — are vying for China’s position as the world’s factory. These lower-cost alternatives are fast becoming developed-country investors’ preferred destinations.

Although the enormous potential of China’s consumer market can provide a new impetus for economic growth, the country’s economic transformation cannot succeed unless it upgrades its manufacturing sector. China’s leaders must begin by increasing investment in science and technology, focusing their efforts on parlaying key technological breakthroughs into higher-value-added production.

Only by combining growing Chinese consumption with enhanced Chinese manufacturing will the country be able to develop a new comparative advantage, which is the key to sustainable growth over the next decade.

Zhang Monan is a fellow of the China Information Center and of the China Foundation for International Studies and a researcher at the China Macroeconomic Research Platform.